The current economic downturn has put airlines in a tough financial position. United’s domestic net-bookings plunged 70%, and Southwest estimated a $200 million to $300 million drop in sales.
To help stem the flow, airline companies are turning to a familiar strategy: Rewards cards.
For decades, airlines have leaned on rewards cards for their steady revenue stream—particularly during industry contractions. In fact, the billions in revenue generated by U.S. airline rewards cards and loyalty programs can, at times, outpace overall sales growth. And that cash definitely comes in handy as airlines plan for a “dire scenario.”
Some estimates based on the first half of 2018 alone show that revenue from rewards cards (pre-sale of miles) can total $3.8 billion for large carriers. The industry will likely tap this additional revenue as it is set to experience an estimated $63 billion to $113 billion in lost revenue due to the coronavirus outbreak, according to Statista.
The ability for airlines to scale loyalty programs can provide a useful lesson for businesses looking to generate recurring revenue—without relying on a subscription model. Further, having upfront revenue (similar to airlines that sell reward miles to credit card companies) can help your business stay afloat during downtimes.
But businesses can be on the other end of that model as a consumer. Therefore, it’s important to understand how loyalty programs can incentivize runaway spending, which can quickly drain travel budgets.
This article will uncover the economics behind rewards cards—as an example of a scalable business model and how it impacts enterprise travel spending. Plus, we’ll provide some tips on better ways to pay (and grow your business) along the way.
1. How airline rewards programs have provided a lifeline during downturns
Rewards cards are a big business—and can provide a billion-dollar cash buffer during hard times.
Here are a few examples:
- 2004: During a time of industry restructuring and the rise of low-cost carriers, Delta sought out $600 million in advanced payment from American Express (Amex), most of it tied to a pre-sale of miles.
- 2008: Delta did it again, taking $1 billion from Amex for an advance purchase of SkyMiles.
- 2008: United took $600 million upfront from Chase Bank as a pre-sale of future miles.
- 2008-2009: American sold future miles to Citi to the tune of about $1 billion in cash flow.
Now let’s talk about how we got here.
Until 1978, the U.S. government viewed the airline industry as a utility, and therefore imposed price restrictions on flights. With the passage of the U.S. Airline Deregulation Act, those restrictions were lifted.
Carriers were able to compete for customers and realized that loyalty is paramount. Businesses needed to provide value-added services in order to keep customers. And for airlines, that meant offering up miles as a reward for passenger allegiance.
American Airlines was the first to launch an airline mileage program called AAdvantage. Days later, United introduced its MileagePlus program, and other airlines followed suit. The original idea was to reward unsold seats to frequent flyers free of charge.
Eventually, airlines ran into a big problem: There weren’t enough seats to accommodate rewards. Airlines were scrambling for a solution to attract and retain travelers.
The old model of earning miles based solely on the distance traveled was broken. Spending on other things to gain miles wasn’t part of the equation back then.
Then came the billion-dollar idea to promote miles as money. Airlines partnered with credit card companies to find ways to keep consumers spending, even if they can’t travel.
Credit card companies began purchasing miles from airlines to reward cardholders—an incentive for consumers to spend more and more. Over the years, this became a big business and produced a cash cow of recurring revenue for airlines.
But it’s not just credit card companies. Airlines decided to go directly to merchants as well. This expanded partnership meant that all parties (airlines, card companies, retailers, hotels, restaurants, and more) met consumers at every point of sale.
Everywhere consumers opened their wallets provided an opportunity to gain miles—enticed by that dream vacation.
2. Why rewards programs strengthen customer loyalty
It’s harder to acquire a new customer than it is to retain an existing customer. This is why more businesses are turning to subscription and membership models to keep customers coming back.
But loyalty is earned, not given.
A good way to keep customers is to offer them an incentive to stick around—and a rewards program is just one example that works.
The concept of influencing consumer behavior with positive reinforcement (rewards) is rooted in psychology. Simply put, getting a reward hits our dopamine centers because we're getting something that feels like it's "free" (even if it actually isn't).
For example, Delta and Amex offer the illusion that we’re getting an instant reward with the SkyMiles card advertisement below. Consumers immediately think that simply signing up for the card will provide them with 10,000 bonus miles. But don’t pack your bags just yet.
In our mind, the reward is still front and center despite having to spend $500 with the new card in the first three months to earn those miles. And the spending behavior is reinforced with the promise of even more miles for continuous spending throughout your card membership.
The goal for airlines is loyalty—carriers want customers to keep coming back. If an airline has a rewards program with a credit card company, it helps guarantee that the credit card company's customers will fly with the carrier again and again.
The more cardholders spend and fly, the closer they get to 10,000 bonus miles—and they’ll tell all their friends. Airlines incentivize these referrals by rewarding more points to cardholders who spread the word.
For businesses, referrals can enable you to multiply customer acquisition over time. After all, as consumers, we’re probably more likely to trust the advice of our peers before making a purchase.
3. How rewards programs help airlines rack up sky-high profits
$7 billion (roughly 16% of Delta’s annual revenue): That’s how much the airline expects an 11-year contract with Amex could be worth by 2023.
Rewards cards might seem like a simple perk for signing up for your favorite credit card, but they generate billions for airlines. Here’s how it works.
Airlines sell miles to credit card companies, which generate instant revenue that accrues over the life of the contract—and it can add up quickly.
“In 2019, Delta disclosed it received $4 billion in cash proceeds from selling miles to Amex. And now, the airline could probably get a year’s worth of pre-sales,” says Joe DeNardi, an analyst with Stifel.
Amex contributes upwards of 35% of Delta’s earnings, and closer to 50% for American Airlines, according to DeNardi. He estimated that carriers were earning large sums of marketing revenue (proceeds that airlines receive from selling miles in excess of the value of the awarded travel) during the first half of 2018 alone.
In turn, the credit card company will rely on payback in the form of cardholder membership fees, merchant transaction charges, and interest—all earned from consumer spending.
As purchasing activity rises, credit card companies demand more miles to fuel more rewards for their cardholders. But here’s the kicker: Not everyone redeems their free miles.
Low-cost carrier Southwest posted 9.6 million in award redemptions, which equates to 14% of total passenger miles, according to Kyros. This uptake is higher than other major airlines, probably due to deal-focused consumers who opt for low-cost carriers—and naturally seek to redeem their earned miles.
But 5% to 8% of total passenger miles seems to be the norm for most large carriers.
“So many Americans roll over their credit card balances each month, which presents a lot of opportunity for profit for both banks [and credit card companies] and airlines,” says marketing consultant Stevan Grosvald.
In fact, a recent report from Forter found that nearly half of loyalty program accounts are inactive.
It’s essentially free cash for the airline, and it underscores the massive profit potential of rewards cards programs.
4. Airlines use rewards programs to compete for status passengers
Rewards programs are also used to attract elite travelers—the high rollers who enjoy life in the sky.
There is a great demand for passengers who travel regularly, especially those with business accounts. Business travelers account for 12% of airlines’ passengers and can represent 75% of an airline's profits on some flights. So, it makes sense for airlines to become the preferred carrier, competing for this elite group.
Recently, in a bid to compete for status passengers, Southwest announced that it would match elite status from any other airline. The goal is to reduce the barrier to entry for frequent travelers who are willing to make the switch to Southwest.
For businesses that manage team travel spending, airlines use similar frequent flyer rewards tactics to earn your loyalty.
Here’s a sample of what some carriers have to offer.
- American’s Business Extra Program: Businesses earn one point for every $5 spent. Points can be redeemed for award flights and upgrades. If you rack up 3,200 points, your company can achieve AAdvantage Gold status (priority boarding plus other perks).
- Delta SkyBonus: Earn points on flights operated by Delta and some partner airlines. Companies that earn 2 million points during a calendar year can qualify for SkyBonus Elite status, which offers 10% more points on top of the normal accumulation rate (plus other perks).
- United PerksPlus: Rewards companies with at least five employees who travel on flights operated by United and some partner airlines. United offers different levels of earning rates, and all points are in addition to MileagePlus miles earned.
Travel and spending incentives can quickly compound—creating an incentive for passengers to maintain their elite status.
And for larger businesses such as Apple, which spends about $150 million on flights with United each year, travel spending programs are typically negotiated ahead of time with the airline.
We assume the rewards and perks are even greater for large corporate travelers. After all, who wants to lose out on the Tim Cooks of the world?
Protect your business from runaway spending
Recurring revenue and maintaining customer loyalty become increasingly important as you scale your business. But, it’s not just the business model that can be useful. Your business should be aware of being on the other end of that model—as the consumer.
The more you grow, the more you spend—and we’ve seen service companies, such as airlines and credit cards, create incentives to influence your purchasing patterns.
We believe businesses can benefit by having greater control over their travel spending by using virtual cards that allow you to set limits, pause, and cancel payments.
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